In recent weeks we have examined in some detail the three balances
approach developed largely by Wynne Godley. In some sense all of that is
preliminary to examining the nature of modern money. Further, as
many of you have no doubt already recognized, a key distinguishing
characteristic of MMT is its view on how government really spends. Beginning with this blog we will begin to develop our theory of sovereign currency.

So in coming weeks we examine spending by government that issues its
own domestic currency. We first present general principles that are
applicable to any issuer of domestic currency. These principles apply to
both developed and developing nations, and regardless of exchange rate
regime. We later move on to analysis of special considerations that
apply to developing nations. Finally we will discuss implications of the
analysis for different currency regimes.

In this blog we examine the concept of a sovereign currency.

Domestic Currency. We first introduce the concept of the money
of account—the Australian dollar, the US dollar, the Japanese Yen, the
British Pound, and the European Euro are all examples of a money of
account. The first four of these monies of account are each associated
with a single nation. By contrast, the Euro is a money of account
adopted by a number of countries that have joined the European Monetary
Union. Throughout history, the usual situation has been “one nation, one
currency”, although there have been a number of exceptions to this
rule, including the modern Euro. Most of the discussion that follows
will be focused on the more common case in which a nation adopts its own
money of account, and in which the government issues a currency
denominated in that unit of account. When we address the exceptional
cases, such as the European Monetary Union, we will carefully identify
the differences that arise when a currency is divorced from the nation.

Note that most developing nations adopt their own domestic currency.
However, some of these peg their currencies, hence, surrender a degree
of domestic policy space, as will be discussed below. However, since
they do issue their own currencies, the analysis here of the money of
account does apply to them.

Note also, following the discussion at the end of Blog 4, we
recognize that individual households and firms (and even governments)
can use foreign currencies even within their domestic economy. For
example, within Kazakhstan (and many other developing nations) some
transactions can occur in US Dollars, while others take the form of
Tenge. And individuals can accumulate net wealth denominated in Dollars
or in Tenge. However, the accounting principles that apply to a money of
account will still apply (separately) to each of these currencies.

One nation, one currency. The overwhelmingly dominant practice
is for a nation to adopt its own unique money of account—the US Dollar
(US$) in America; the Australian Dollar (A$) in Australia; the
Kazakhstan Tenge. The government of the nation issues a currency
(usually consisting of metal coins and paper notes of various
denominations) denominated in its money of account. Spending by the
government as well as tax liabilities, fees, and fines owed to the
government are denominated in the same money of account. The court
system assesses damages in civil cases using the same money of account.

For example, wages are counted in the nation’s money of account and
in the event that an employer fails to pay wages due, the courts will
enforce the labor contract and assess monetary damages on the employer
to be paid to the employee.

A government might also use a foreign currency for some of its
purchases, and might accept a foreign currency in payment. It might also
borrow—issuing IOUs—in a foreign currency. Usually, this is done when
the government is making purchases of imports or when it is trying to
accumulate foreign currency reserves (for example when it pegs its
currency). While important, this does not change the accounting of the
domestic currency. That is, if the Kazakhstan government spends more
Tenge than it collects in Tenge taxes, it runs a budget deficit in Tenge
that exactly equals the nongovernment sector’s accumulation of Tenge
through its budget surplus (assuming a balanced foreign sector it will
be the domestic private sector that accumulates the Tenge).

We will argue that the government has much more leeway (called
“domestic policy space”) when it spends and taxes in its own currency
than when it spends or taxes in a foreign currency. For the Kazakhstan
government to run a budget deficit in US Dollars, it would have to get
hold of the extra Dollars by borrowing them. This is more difficult than
simply spending by issuing Tenge to a domestic private sector that
wants to accumulate some net saving in Tenge.

It is also important to note that in many nations there are private
contracts that are written in foreign monies of account. For example, in
some Latin American countries as well as some other developing nations
around the world it is common to write some kinds of contracts in terms
of the US Dollar. It is also common in many nations to use US currency
in payment in private transactions. According to some estimates, the
total value of US currency circulating outside America exceeds the value
of US currency used at home. Thus, one or more foreign monies of
account as well as foreign currencies might be used in addition to the
domestic money of account and the domestic currency denominated in that
unit.

Sometimes this is explicitly recognized by, and permitted by, the
authorities while other times it is part of the underground economy that
tries to avoid detection by using foreign currency. It might be
surprising to learn that in the United States foreign currencies
circulated alongside the US dollar well into the 19th century; indeed,
the US Treasury even accepted payment of taxes in foreign currency until
the middle of the 19th century.

However, such practices are now extremely rare in the developed
nations that issue their own currencies (with the exception of the Euro
nations—each of which uses the Euro that is effectively a “foreign”
currency from the perspective of the individual nation). Still it is not
uncommon in developing nations for foreign currencies to circulate
alongside domestic currency, and sometimes their governments willingly
accept foreign currencies. In some cases, sellers even prefer foreign
currencies over domestic currencies.

This has implications for policy, as discussed later.

Sovereignty and the currency. The national currency is often
referred to as a “sovereign currency”, that is, the currency issued by
the sovereign government. The sovereign government retains for itself a
variety of powers that are not given to private individuals or
institutions. Here, we are only concerned with those powers associated
with money.

The sovereign government, alone, has the power to determine which
money of account it will recognize for official accounts (as discussed,
it might choose to accept a foreign currency for some payments—but that
is the sovereign’s prerogative). Further, modern sovereign governments,
alone, are invested with the power to issue the currency denominated in
its money of account.
If any entity other than the government tried to issue domestic
currency (unless explicitly permitted to do so by government) it would
be prosecuted as a counterfeiter, with severe penalties resulting.

Further, the sovereign government imposes tax liabilities (as well as
fines and fees) in its money of account, and decides how these
liabilities can be paid—that is, it decides what it will accept in
payment so that taxpayers can fulfil their obligations.

Finally, the sovereign government also decides how it will make its
own payments—what it will deliver to purchase goods or services, or to
meet its own obligations (such as payments it must make to retirees).
Most modern sovereign governments make payments in their own currency,
and require tax payments in the same currency.

Next week we will continue this discussion, investigating “what backs up” modern money.